In This Article:
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Aurelia Metals Limited's (ASX:AMI) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Aurelia Metals's P/E ratio is 5.38. That means that at current prices, buyers pay A$5.38 for every A$1 in trailing yearly profits.
View our latest analysis for Aurelia Metals
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Aurelia Metals:
P/E of 5.38 = A$0.69 ÷ A$0.13 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, Aurelia Metals grew EPS like Taylor Swift grew her fan base back in 2010; the 64% gain was both fast and well deserved.
How Does Aurelia Metals's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (12.5) for companies in the metals and mining industry is higher than Aurelia Metals's P/E.
This suggests that market participants think Aurelia Metals will underperform other companies in its industry. Since the market seems unimpressed with Aurelia Metals, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.